What is Risk to Reward Ratio
The risk-to-reward ratio is used to weigh a trade's
potential reward (profit) against its possible risk (loss). Whether a trade
results in a profit or a loss, stock traders and investors utilise the R/R
ratio to set the price at which they will close it out.
In most
cases, a trader will use a stop-loss order to get out of a position if it
begins to move in the opposite way from what they had anticipated.
Whether prospective returns surpass risk or vice
versa depends on the relationship between risk and reward. In essence, the R/R
ratio aids traders in deciding whether a certain trade is worthwhile.
For example - An investment with a risk-to-reward
ratio of 1:7 indicates that the investor is willing to take a Rs.1.00 risk in
exchange for the chance to make a Rs.7.00 profit. An investor should anticipate
to invest Rs.1.00 with the potential to gain Rs.3.00 in return if the
risk/reward ratio is 1:3.
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